Top Heavy

Hello,

We are trying to figure a possible way out of a top heavy issue and would appreciate any thoughts.

Facts:

• Calendar year 401(k) Plan. Does not allow profit sharing contributions.
• Plan has been safe harbor (safe harbor match) for several years and the employer elected to stop the safe harbor match effective 1/1/2023.
• Safe Harbor Match is an annual match and is calculated and funded after the end of the year. They are getting ready to submit their 2022 required safe harbor match now. 
• The Top Heavy ratio as of 12/31/2022 is 61% calculated on a straight cash basis, i.e. no receivable accrued. This would mean the plan is top heavy for 2023.

We came up with a couple of ideas that we hope might allow the plan to not be considered top heavy for 2023.

1. If we accrue the 2022 safe harbor contribution in our 12/31/2022 balances the top heavy ratio drops to 59%. I looked into this and came across the IRS Q&A from 2002 concerning contribution receivables. Do you think it would be permissible to include the required 2022 safe harbor match in the 12/31/2022 balances for top heavy testing?
2. Establish a new profit sharing plan retroactive for 2022 and make a $15,000 contribution to non-key employees. If we could include that $15,000 in our 12/31/2022 balances for top heavy testing then the plan would not be top heavy for 2023.

Do you think either of these to options would work? I appreciate any thoughts or comments.

Thank you!

One would hope that the loss of the top heavy exemption was discussed with the plan sponsor before they decided to remove the safe harbor match from their plan. Therefore, they should not be surprised that they are now subject to the top heavy minimum.

As you noted, there is the 2002 IRS Q&A suggesting that they would accept the use of an accrual method for determining the top heavy ratio in a profit sharing plan, even though that is contrary to the text of the 1984 regulations. You might want to explain the situation to the client and let them decide if they are comfortable relying on the opinion from the Q&A, if it means they can save the cost of a top heavy minimum contribution for 2022.

Just because the plan doesn't allow "Profit Sharing" contributions doesn't mean you can't make a TH contribution.  The plan document says that if the plan is TH then the ER must make a TH contribution.  it is a completely separate and distinct contribution from a PS.

It's just that most companies declare a PS in an amount enough to satisfy the TH, but you don't have to.

Plus, why go through all the expense of starting a new plan, funding it, filing a 5500, terminating it and transferring the small balances to the "main" plan?

1. BG, the $15k for 2022 would not be a TH contribution, but a contribution to 2022 to avoid TH in 2023.

2. what is happening to possibly trigger a needed TH contribution for 2023?

Bill, you are correct. The $15k would be a contribution for 2022 to avoid TH in 2023.

To your 2nd point, a Key employee has already made a 401(k) contribution in 2023 that will most likely exceed 3% of annual pay. Ouch!

For what it’s worth, this is the only relevant Q&A I could find in the Gray Book (discontinued after 2015).

QUESTION 2003-37

DC Plans: Receivable Contribution and Top-Heavy Determination

Q&A T-24 of the 416 regulations says that if a plan is not subject to 412, then the account balances are not “adjusted” to reflect a contribution made after the determination date.  Most practitioners have taken this to mean that non-412 plans (profit-sharing) should not take into account contributions actually made after the end of the plan year, but that such receivables should be taken into account for 412 plans (money purchase) along with adjustments for waived contributions.

Is this a correct interpretation? If not, what is supposed to be excluded?

RESPONSE

The term "account balance" in the regulations includes contributions credited to the account of a participant as of the determination date, not just the contributions actually made. This is the balance communicated to plan participants as opposed to a cash basis of accounting reflecting actual assets on hand at that date. The rule addressing adjustments to the account balance for contributions made after the determination date, applies to any waived funding deficiency that is not considered part of the participant's “account balance” until paid.

Another thought that came to mind would be to retroactively adopt a money purchase pension plan for 2022. Since that plan would be subject to the minimum funding standards of Code Section 412, any accrual for that plan would count in our top heavy ratio determination at the end of 2022. You could set a contribution formula just high enough to make the plans not top heavy for the 2023 plan year.

Have not thought through how long that money purchase plan would need to be in existence and if it would be worth the extra effort and costs to maintain it.